US commercial mortgages worry Fed amid defaults

New York

JUST outside Columbus, Ohio, the small city of Gahanna seemed to be catching a break in its decade-long struggle to transform an underused strip of downtown into a district of retail shops, high-end condominiums and restaurants.

With a second developer to pick up where a predecessor failed, the project, known as Creekside, found a new backer last year: Wall Street's US$100 billion-a-year securitisation machine for commercial mortgages. A US$25 million loan from UBS Group AG was quickly scooped up with five dozen others, bundled and sold to pension funds and money managers as bonds with ratings as high as AAA.

Within six months, the developer defaulted. The loan's set to be auctioned on Wednesday, and bondholders are facing potential losses. For analysts and investors that have tracked the rapid growth of commercial-mortgage backed securities (CMBS) since the crisis, the failure is raising questions not just over how the loan…